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Wednesday, December 24, 2008

Scott Adams Talks Finance

I’ve been a fan of Scott Adams’ Dilbert cartoons for many years. I spent most of my career in a small cubicle lined with cloth, and his cartoons captured the essence of my work-related frustrations and fears with humour. Many of his cartoon-based comments on financial crises over the years have been right on the mark. However, Adams’ latest blog post misses the mark by a wide margin.

To be fair, Adams doesn’t always believe the things he says on his blog. He likes to throw out half-baked ideas and stir the pot. Consider my pot to be stirred.

Here is the essence of Adams’ argument about stocks:

1. People aren’t smart enough to pick their own stocks.

2. People should be limited to investing in indexes or special regulated funds run by experts. He also wants stock prices to be set by “some sort of regulating board.”

To borrow from a well-known quote about democracy, capitalism is the worst way to run an economy except for all the other ways. One of the core benefits of democracy and capitalism is the lack of concentration of power. Capitalism works well until one market participant begins to dominate and has to be regulated. Unfortunately, Adams is suggesting that we round up much of the spread out power of our capitalist system and concentrate it in official funds and regulating boards. This is a bad idea. Power corrupts.

I agree with Adams that most people would be better off investing in index funds rather than buying individual stocks. But, I think it is crucial that people retain the choice to invest as they please.

One sign of a reasonable person who argues fairly is that he considers arguments against his position. Adams definitely passes this test by raising the Warren Buffett argument. Buffett has been a spectacularly successful investor, and wouldn’t it be unfair to prevent the next Buffett who comes along from succeeding in the same way?

Adams counters this argument with two points:

1. “Warren Buffett buys companies, not stocks.”

2. “If every investor picked stocks entirely randomly, you would still produce a good number of Warren Buffetts entirely by chance.”

Adams is wrong on both points. Buffet’s most successful investing years happened early on before he had enough capital to buy entire businesses. He bought stocks.

If we stopped Buffett’s career early on, we could reasonably say that a few investors would be expected to have results as good as his by chance. However, Buffett continued to outperform for decades. The probability that any one person would succeed as Buffett has by random chance is far less than one in a billion. Buffett has proven that he is the real deal and not some monkey throwing darts at a stock page.